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Google's Big-Bucks Expansion Plans

By Alex Salkever When Google bared its soul on Apr. 30 by filing to go public, it released hundreds of pages of documents offering a detailed look into the secretive and highly profitable search giant's inner workings. These peeks revealed some very interesting things. On an operating-profit basis, Google could be pocketing as much as 59% of its annual revenues. That number would make most CEOs turn an envious shade of green -- and set investors salivating.

It will also allow Google to sink an enormous chunk of change into capital spending in the coming year -- a quarter of a billion dollars worth in 2004, according to the S-1 filed with the Securities & Exchange Commission. That's nearly 25% of 2003 revenues, and it'll come on top of 2003's $175 million in capital outlays.

The question is: Should Google be spending that much as it prepares to enter the universe of publicly traded companies? By most accounts, that's more than it would need to expand its existing search-engine and technology infrastructure. "For a technology company, [the number] does seem awfully high," says Paul Bard, an IPO analyst at Renaissance Capital in Greenwich, Conn., who adds: "For a company like Google, I would expect it to be well under 10%."

REPLACEMENT COSTS. Google's massive tech backbone already comprises 100,000 servers at data centers spread around the globe. And it has made a point of spending as little as possible on tech, building its own servers from low-cost components and writing its own software to take advantage of a massive network of cheap, easily replaceable machines.

So what's behind the big spending plans? A number of factors could be at work. The cost of expanding into new data centers -- those gigantic assemblies of Internet servers that make Google work so quickly from almost everywhere -- won't be cheap. And the price of additional bandwidth and data transport from these centers, needed to keep Google's performance snappy, also will continue to rise.

While Google does spend as little money as possible on machines, its hardware-replacement costs are still likely considerable, says Jim Pitkow, a former Google employee and the current CEO of Moreover, a San Francisco company that sells customized news-search engines to corporations. Says Pitkow: "They definitely need to refresh a lot of their hardware."

PET PROJECTS. And Google is hiring like crazy, which means more office space, chairs, desks, computers, and monitors -- lots of monitors, since many employees a pair of large, flat-panel displays. Still, Pitkow admits that even these costs won't come close to equaling the total capital budget Google has laid out.

One big reason why its spending plans may be so expansive: Gmail, Pitkow says. The new e-mail service will require a massive injection of computing memory into the Google infrastructure. "If you want to run Web mail and have it be truly ubiquitous, then copies of people's mail accounts will have to exist across the system," he says. So, even if a Gmail account holder only has 500 megabytes of mail -- half the system's capacity -- Google will need to create enough storage space across its network to handle several times that amount in order to backup the account.

Another potentially large drain on resources is Google's plethora of in-house projects. These are an integral part of the strategy to bring out new services, and even though they're mostly in test stages, they still require additional computing horsepower. Finally, Google is expected to launch big new offerings over the coming year. These could make it more of match for Yahoo! (YHOO), such as a dating service or enhanced Internet community/group offerings.

DELIVERING THE GOODS. Or maybe Google has a few more surprises up its sleeve. It sure looks like the triumvirate of Larry Page, Sergey Brin, and Eric Schmidt are up to something beyond pure search. Engineering Vice-President Wayne Rosing has on several occasions emphasized that Google's primary expertise is in so-called distributed computing. That's a fancy way of talking about delivering applications to a computer user's browser or to remote locations. For now, Google does that with the Internet search function. Soon, it will be free e-mail.

And after that? Those in the know say Google has plenty of other distributed-computing offerings under consideration. They could range from Microsoft (MSFT) Office-like word processing or spreadsheets to distributed media libraries for music and video lovers. Regardless, any service that needs to handle tens of millions of users will need loads of new computing power.

For most public companies, devoting 25% of revenues to capital spending would trigger frowns on Wall Street. But once again, Google is surprising critics and going against the grain. As it prepares for a groundbreaking initial public offering, spending $250 million to expand and innovate is what Google execs think their company needs as it prepares to grow in multiple directions simultaneously. Salkever is Technology editor for BusinessWeek Online

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